Beware: slippery when oily

The UK's growing army of private investors has had a nerve-racking few weeks, with fears of rising oil prices sending the FTSE 100 skittering down by over 600 points in a fortnight. Yet when everyone came back from their summer holidays at the end of August, it all looked so different (see graph inset). The FTSE index of blue-chip shares had finally broken out of the 6,000-6,100 range it had been stuck in for most of the year, and some pundits forecast a rise to 7,000 by Christmas.

The UK's growing army of private investors has had a nerve-racking few weeks, with fears of rising oil prices sending the FTSE 100 skittering down by over 600 points in a fortnight. Yet when everyone came back from their summer holidays at the end of August, it all looked so different (see graph inset). The FTSE index of blue-chip shares had finally broken out of the 6,000-6,100 range it had been stuck in for most of the year, and some pundits forecast a rise to 7,000 by Christmas.

This week we're back to the 6,100 range with a bump. Polling a number of leading equity pundits, The Independent has come up with something of a consensus on one point, at least: volatility in the markets is likely to continue.

Jeremy Batstone, head of research at NatWest Stockbrokers, says that with more price gyrations in store, people must think carefully about whether they have the right attitude for investing in such conditions.

"Many people have been sucked into share-investing by the wholly unusual tech bubble of the last 18 months. They think they will win every time. But choppiness is part and parcel of the markets these days," Mr Batstone warns.

The main culprit is, of course, the rising price of oil, which has tripled in 12 months to over $34 a barrel, with fears of more rises ahead. That in turn has led to a rash of profits warnings by big industrial companies in the US, which in turn has prompted fears that the global economy is set to slow down much more sharply than previously thought.

If you're worried that the fuel crisis may be prolonged, Mr Batstone suggests buying oil stocks as a defensive hedge. The two obvious shares, BP Amoco and Shell, are not as cheap as they were six weeks ago. For instance, Shell has risen by about 6 per cent over the last four weeks, and 20 per cent over the last year. But the shares still represent a protection against high oil prices, Mr Batstone thinks.

Utilities should be beneficiaries of the lack of enthusiasm for the technology sector and, to a lesser extent, telecoms. Mr Batstone reckons the recent worries over telecoms have been overdone, such as the high prices paid by the phone companies for the third-generation mobile phone licences in the UK. He therefore tips BT, which has sunk from over 1200p at the turn of the year to just 808p earlier this week, when its plans for a link with AT&T were announced. "We're looking forward to a revival - and there can't be much more downside in the BT price."

He is also keen on telecom equipment manufacturers, such as Marconi. "We still like pharmaceuticals - a quintessential defensive growth sector. Particularly Astra Zeneca, which has announced good news recently. Its ulcer drug Losec, which accounts for 40 per cent of its sales, is about to go off-patent. But a replacement drug, Nexium, is being trialled in Scandinavia."

Other UK pundits compare current conditions to the weather. Justin Urquhart Stewart of Barclays Stockbrokers says: "We're getting our October storms early. The markets are turning out like the weather - soggy."

There are three great worries overhanging the stock market, Mr Urquhart Stewart says: inflation, interest rates and oil prices. He thinks there will be little real growth in the stock market until there is better news on all three. But if that trio of factors does improve, then the markets could bounce back within a fortnight. "My advice is to sit on your cash until then. Meanwhile, spend the time deciding which shares will benefit most from a recovery."

So which companies does he think will benefit from a bounce-back? Mr Urquhart Stewart favours telecoms, such as Cable & Wireless, as well as clearing banks, which have taken a bit of a caning recently. Also, quality technology stocks, such as Pace Micro, which makes the set-top boxes for digital television. But avoid less well-established tech stocks, he warns. "Pace has products, contracts, and make money. Whereas a lot of stocks that came a cropper when the internet bubble burst just had a good idea. This is not the time to be investing in just good ideas."

Mr Urquhart Stewart believes the current choppy markets are being caused not so much by people selling, but by investors sitting back and saying to themselves: "Why should I buy?" The lesson is clear, he says.

"You should keep your cash in the building society for the moment. There is some volatility still to come, especially on Nasdaq."

Away from the pundits, the British public still seems to have faith in tech stocks, according to a survey published this week. Of 2,856 investors surveyed about the future of tech stocks, 75 per cent felt they were going to rise. Almost 40 per cent predicted another strong bull run. The survey, by UK-iNvest.com, also found that a mere 10 per cent expected tech stocks to sink back down to where they were in the summer.

Returning to the Square Mile, Steve Russell, UK equities strategist with HSBC, has good news and bad news: "Despite the oil-induced volatility, we still see the FTSE hitting our target of 6,900 by the end of the year. But if you look at individual sectors, things become a lot more complicated.

"We're worried by the prospects for [slower] global growth. Industrial shares are not the place to bargain-hunt at the moment. Even with TMT (telecoms, media, technology) shares, it's still a struggle to find value."

One sector still looks good, says Mr Russell: software. He especially likes longer-established software companies with proven management.

Mr Russell is the first to admit that following his advice would leave you with a "dull and defensive portfolio." So what are his boring-but-safe share tips? The food producers Unilever and Cadbury, beverages companies Diageo and Allied Domecq, and the utilities companies. For the future, Mr Russell is pinning his hopes on an interest-rate cut early next year, which should finally spur a rally in the markets.

Jason Hollands, deputy managing director of Best Investment, a fund analysis company, has one simple message for private investors: "Don't panic. We are in for a period of very sustained stock-market volatility. We are also seeing a lot of 'rotation' between different sectors. One week everyone's piling into tech stocks, then next, they're moving back into old-economy stocks because they're seen as undervalued."

There is also a divergence between large and small companies, he says. The FTSE 10 of big blue-chips' shares has risen by only 9 per cent in the year to 15 September, whereas the FT Small Capital Index has gone up by 30 per cent.

One thing you must avoid if you're investing for five years or more, says Mr Hollands, is panic selling. Anyone who has put money into a PEP or ISA and intends to hold it for the long term would be a fool to sell now, he reckons.

One group that should be concerned is people with three or four years until retirement. They've built up a pension fund but don't want to go into cash yet, as they want a few more years of growth from equities. Yet they don't want to suffer any losses. Mr Hollands recommends a protected equity fund. It is a fairly expensive scheme that involves putting a portion of your fund into options, stock market instruments that insure you against a fall in the market. If the market falls below a certain predetermined level, you get compensated. If it rises, you lose the value of the option.

One other hedge for cautious investors is to go into property, via a fund. Mr Hollands likes the Portfolio Property Fund, run by Portfolio Fund Managers, a company with links to one of the UK's biggest developers.

That's for cautious people. But for the brave, Mr Hollands declares: "If you can stomach volatility and are prepared to 'buy on the dips', then this is quite an exciting time to invest." Good luck.